Insider Traders Outside U.S. Safe From American Prisons

On Dec. 17, 2010, the California biotechnology firm said European Union regulators had recommended approval of the medicine for sale in Europe. Its shares rose 144 percent, while some options to buy the stock gained more than 500 percent.

Six days later, lawyers for the Securities and Exchange Commission rushed into Manhattan federal court, claiming “unknown purchasers” used London accounts to buy 637 InterMune options contracts on U.S. exchanges days before the news. Regulators said they immediately suspected insider trading. While SEC lawyers didn’t know who bought the contracts, or where their tip came from, they persuaded a judge to freeze the accounts and block the sale of options worth as much as $912,000.

The agency soon figured out who was behind some of the InterMune trades. Within weeks, a lawyer for Michael Sarkesian, a Swiss citizen and ex-grain trader, came forward to say his client had bought 400 options. Sarkesian, who had traded through Quorne Ltd., a British Virgin Islands entity he managed for a relative, denied using inside tips. A year later, he agreed to return his profit on the trades and pay a $93,806 penalty.

The case is part of an increasing SEC focus on insider trading by overseas buyers of U.S.-traded securities, as seen in cases stretching from China to Lebanon to Switzerland. Since 2010, the agency filed three times as many emergency asset-freeze requests in such cases as in the prior two years. The regulator cited suspect trading patterns, typically before mergers or other market-moving news.

Significant Obstacles

Unlike domestic insider cases that include SEC suits and Justice Department prosecutions, overseas trading probes present significant obstacles to criminal charges. In only one recent case did the U.S. follow an SEC case with related charges, due in part to difficulties in obtaining evidence and extraditing foreign defendants. The SEC requested the government consider charges against overseas traders less frequently in such cases than in domestic probes, said one ex-assistant U.S. attorney.

“We had to evaluate the likelihood of bringing them to justice in the U.S.,” Christopher Garcia, who was chief of the Manhattan U.S. Attorney’s white-collar crime unit until February, said of the SEC’s referral of overseas cases to the Justice Department.

As a result, foreign insider traders, while at some risk of losing their money, face very little chance of going to prison.

“You will lose not only your profits but also your principal,” Peter Henning, a law professor at Wayne State University and former SEC lawyer, said in an interview. “But I haven’t seen any cases where people will be extradited.” Henning added, however, that “If you are identified” as trading on illegal tips, “you had better not come to the U.S.”

‘A Challenge’

Douglas Leff, assistant special agent in charge of the New York office of the Federal Bureau of Investigation, said “it’s always a challenge for us to get records that are in the control of countries other than the U.S.”

If a country doesn’t recognize insider trading as a crime, “it’s harder for us to investigate,” Leff said in an interview. At the same time, there’s a “significant amount of mutual assistance” from other nations, and traders operating illegally overseas may be arrested if they come to the U.S. or another country with a U.S. extradition treaty, he said.

InterMune Probe

Trades in InterMune stock are also tied to the U.S. insider trading probe of hedge fund SAC Capital Advisors LP, now the focal point of a five-year crackdown by federal prosecutors, according to a person with knowledge of the matter. The person asked not to be identified because the matter isn’t public.

The SEC has filed at least 10 emergency action cases related to overseas trades since 2010, compared with only three over the previous two years. The 10 cases involved traders in China, Switzerland, Hong Kong, Singapore, Spain, Belgium, Lebanon and Austria, according to court records. In total, the SEC claimed illegal profit of $32 million.

“When you freeze money, it has a way of getting people’s attention,” Daniel Hawke, director of the SEC’s Market Abuse Unit, said in an interview. “People don’t walk away from it.”

In each case, the regulator argued profits would vanish overseas without an emergency asset freeze. Judges have always granted the agency’s request.

“There are a significant number of cross-border transactions that include non-U.S. advisers -- lawyers, auditors, investment bankers -- so it’s not just insiders who we’re looking at in these investigations,” Scott Friestad, the SEC’s associate enforcement director, said in an interview. “This multiplies the potential for leaks around the world.”

Increased Globalization

Friestad said the cases come in response to increased globalization, especially takeovers that involve foreign or American companies trading on U.S. exchanges. Also, traders can more easily buy and sell securities through online brokers while masking their identity through offshore firms, he said.

In some instances, overseas traders simply abandon funds frozen in the U.S., he said. But the SEC doesn’t always prevail, either. Traders won outright in several recent cases, and in some instances the agency has returned a portion of the frozen funds to the defendant as part of a settlement.

The broader U.S. government crackdown on insider trading has led to civil or criminal cases against 449 people over the past five years, according to data compiled by Bloomberg. That includes 125 people this year, up from 56 in 2008. Almost all live in the U.S.

Foreign, Domestic

In cases against U.S. residents, regulators and prosecutors may spend many months or years assembling documents and questioning witnesses to develop evidence showing that a trader used illicit tips from friends, family or business associates.

In the foreign cases, though, the SEC typically goes to court within days of a market-moving announcement, usually using its own trading data or information from the Financial Industry Regulatory Authority or the Options Regulatory Surveillance Authority. The goal is to win an asset freeze and block the investor -- whose identity may or may not be known -- from moving cash overseas before the trades settle.

“If you fail to prevent the money from going offshore, you can do an investigation and never be able to hold those people accountable,” Hawke said. “We would be criticized if we failed to file a case, money went offshore, and it turned out those were the proceeds from an insider trading case.”

Hong Kong

The SEC won a $14.2 million settlement last month from Hong Kong-based Well Advantage Ltd. The defendants included unknown traders in Hong Kong and Singapore of securities for Calgary-based Nexen Inc.

Regulators accused them of buying Nexen shares on the New York Stock Exchange before an announcement of the company’s acquisition by Cnooc Ltd. (883), China’s largest offshore oil and gas explorer. The Well Advantage settlement came after the SEC won an order freezing more than $44 million in assets held by all the defendants.

Well Advantage is indirectly wholly-owned by billionaire Zhang Zhi Rong, who is also the controlling shareholder of China Rongsheng Heavy Industries Group Holdings Ltd. (1101), a Hong Kong-based company, the SEC said. China Rongsheng does significant business with Cnooc, according to the agency. Profit of Well Advantage, incorporated in the British Virgin Islands, topped $7 million. Other traders still being sued earned millions of dollars more, the regulator said. The SEC didn’t file a complaint against Zhang Zhi Rong.

Beefed-Up

Beefed-up enforcement by U.S. regulators focusing on overseas trading helped detect the suspicious trading, one official said.

“We had a team of people who had looked at it, and we had broker-dealers identifying any trading coming from non-domestic forces,” said Cameron Funkhouser, head of Finra’s office of fraud detection and market intelligence.

“We learned within hours of the announcement that there was suspicious trading coming in from foreign broker-dealers.”

Well Advantage didn’t admit or deny wrongdoing. In the $14.2 million settlement, the company was able to recover another $7 million that the SEC had frozen in its emergency action, according to court records.

Alan Brudner, a Well Advantage lawyer, declined to comment on the settlement.

Lung Drug

The InterMune case involving Esbriet, its lung disease drug, was one of five foreign insider trading cases filed since 2010 in which investors traded through a British Virgin Islands entity.

Sarkesian used the BVI-based entity, Quorne, to buy InterMune options after a source tipped him that the EU’s Committee for Medicinal Products for Human Use would recommend approval of Esbriet in December 2010, according to the SEC.

“The material nonpublic information obtained by Sarkesian, after which he caused Quorne to purchase InterMune call options, was disclosed to him for a personal benefit to the source of that information,” the SEC said in court papers. The agency didn’t identify who allegedly tipped him, or what that person got in return.

In March, Sarkesian and Quorne settled with the SEC, agreeing to hand over $616,000 in profit and a $93,806 penalty. Neither admitted wrongdoing. The SEC claims involving another 237 InterMune options were dismissed after the buyer came forward and provided a legitimate reason for the trades. The agency didn’t identify the buyer. Sarkesian’s New York-based lawyer, Michael Dailey, declined to comment on the settlement.

SAC Capital

The U.S. investigation of InterMune trades by SAC Capital, the Stamford, Connecticut-based $14 billion hedge fund founded by billionaire Steven Cohen, focuses on the first half of 2010, a person acquainted with the case said. InterMune’s stock soared in early March 2010 after the drug company’s experimental medicine was reviewed more favorably by U.S. regulators than analysts had expected.

SAC, as well as affiliates CR Intrinsic and Sigma Capital Management, bought more than 4 million shares of InterMune in the first quarter of 2010, increasing its holdings to almost 4.5 million shares from none in the prior two quarters, according to data compiled by Bloomberg.

Jonathan Gasthalter, a spokesman for SAC Capital, said the hedge fund is unaware of investigations related to InterMune. Jim Goff, a spokesman for Brisbane, California-based InterMune, declined to comment on the cases.

Documenting Leaks

Unlike the domestic probe of SAC Capital’s InterMune trades, documenting leaks involving European drug approvals, Asian companies in merger talks or South American stock brokers swapping takeover tips is problematic for U.S. authorities because the action often takes place outside their jurisdiction.

Instead, the agency files a complaint in federal court on the discovery of red flags, like a trader’s unprecedented use of options or a sudden interest in a soon-to-be-acquired company, seeking to freeze assets. But the subsequent investigative hurdles can be daunting.

“Sometimes we have to pierce through four or five different levels of corporate structure before we can get behind the trading,” Friestad said. “When individuals are in foreign jurisdictions, there are limits on our ability to serve subpoenas and get information efficiently.”

One setback for the SEC came this year after the agency sued unknown buyers of securities in Spain’s Telvent GIT SA. Two days earlier, Schneider Electric SA (SU), the world’s biggest maker of low- and medium-voltage equipment, said it would buy Telvent. The agency said the buyers made $475,000 in illicit profit.

Lebanon Firm

They called themselves “innocent victims of an investigatory net cast too wide.”

Only after suing did the SEC review hundreds of trading records and question Khalife, according to his lawyer, Jeffrey Eilender. The agency told a judge in May that it planned to dismiss the suit. It has yet to do so.

“Mr. Khalife wants to be vindicated,” Eilender said in an interview, adding that his client had legitimate reasons for his trades. “This case has already ruined Iris Capital’s business.”

Another investor who responded to a SEC lawsuit, Madrid resident Luis Sanchez, persuaded a Chicago federal judge last year to dismiss the SEC claim that he’d bought options after being tipped about a 2010 takeover offer for Potash Corp. (POT) of Saskatchewan Inc., the world’s largest fertilizer producer. After he was sued in 2010, Sanchez said at a deposition that he’d been following Potash’s industry for many years, according to court records.

’No Evidence’

The SEC claimed Sanchez erased his computer hard drives, which he denied, according to court papers.

“There was no evidence of an insider who passed on inside information,” his lawyer, Jonathan Buck, said in an interview.

That may have been because Sanchez “wiped his hard drive clean and trashed his laptop,” Hawke claimed. “He was in Spain and there were limitations on what we could do.”

The SEC sued another Spaniard, Juan Garcia, who headed the European equity derivatives division at Banco Santander SA (SAN), which advised BHP Billiton Plc in its takeover bid for Potash.

Garcia settled the case by paying $626,033. He neither admitted nor denied wrongdoing. Other than both being residents of Madrid, the SEC “has not demonstrated any other connection” between Sanchez and Garcia, the judge said.

Seeking Fight

U.S. oversight of overseas trading isn’t new. In 2008, for instance, former Dow Jones & Co. (NWSA) director David Li and three other Hong Kong residents paid more than $24 million to settle an SEC probe into trading before the 2007 takeover by News Corp.

Now, the scrutiny is more intense.

“Our view,” said Finra’s Funkhouser, “is that any M&A announcement could lead to leakage anyplace, anywhere in the world.”

Defense attorneys for overseas traders, aware that the SEC’s evidence may be lacking, are increasingly seeking to fight cases rather than settle.

The SEC sued Yonghui Zhang, a Chinese trader accused last year of using inside tips about the takeover of Beijing-based Global Education & Technology Group Ltd -- where his brother is the CEO. Zhang’s lawyers told a judge this month that the SEC has had enough time to investigate. Defense lawyers said in court papers that they are eager to file a dismissal request.

Jerry W. Markham, a law professor at Florida International University and a former chief counsel for the Commodity Futures Trading Commission’s enforcement division, said overseas regulators, while responsive to SEC document requests, usually aren’t as vigilant in fighting insider trading at home.

“Insider trading is really an American concept,” Markham said. “It has spread abroad -- England is more active -- but it’s never the same over there.”